On July 13, 2012, two defendants in an SEC enforcement action moved to dismiss the SEC's complaint, in part on the grounds that Section 304 of SOX was unconstitutional as applied to them. According to the complaint, the SEC sued the two defendants for not reimbursing their company for compensation they received after two separate employees engaged in a scheme that caused the company to issue inaccurate financial reports. Importantly, the SEC did not allege that either of the two defendants participated in, or even knew about, the underlying misconduct that caused the inaccurate financial reporting. Section 304 of SOX allows the SEC to require reimbursement when a material noncompliance with financial reporting requirements is "result of misconduct," but the statute does not specify whose misconduct, or what kind of misconduct triggers the reimbursement obligation.
The defendants argued that the SEC's interpretation of SOX 304 would be unconstitutional because it would force innocent individuals to pay penalties for the misconduct of others without fair notice that their lawful activity could subject them to liability. According to the defendants, requiring innocent executives to reimburse a corporation under the SEC's interpretation would make it impossible for executives to determine when the SEC would have a valid claim because the SEC's interpretation would essentially allow it to seek reimbursement whenever a financial restatement was issued as a result of any kind of misconduct by anyone. The defendants instead argued that the appropriate interpretation of SOX 304 would only require reimbursement when a financial restatement occurred as a result of the particular executive's misconduct, which would constitute an independent violation of the securities laws. The SEC is opposing the defendant's motions and believes that SOX 304 is constitutional even as applied against innocent executives. The defendant's motions are currently set for hearing and the outcome could have far-reaching implications for future SEC enforcement actions.
SEC v. Michael A. Baker et al., case number 1:12-cv-00285, in the U.S. District Court for the Western District of Texas.